By Talha Khan
Capital Group Political Economist
French voters will choose a new president next month in a pivotal election that has taken on global significance. With a rising wave of populism moving across Europe, the United States and elsewhere, investors are worried that France may be the next domino to fall, sweeping away the old-guard establishment and rejecting the geopolitical order that has dominated Western democracy since the end of World War II.
These fears were stoked by Donald Trump’s rise to the U.S. presidency and last summer’s Brexit referendum, which resulted in the U.K. moving to extricate itself from the European Union. One of the French presidential candidates, Marine Le Pen, has even been called the Donald Trump of France, which is not entirely accurate. Le Pen taps into some of the sociocultural and economic anxieties that President Trump did with his voter base, but her party – the National Front – has a longstanding history in French politics and she is not a new voice on the political spectrum.
France’s presidential election will unfold in two rounds. The first round, featuring 11 candidates, is scheduled for April 23. The second round, a runoff between the top two vote-getters, is set for May 7. The winner will replace François Hollande, who chose not to seek reelection amid record-low approval ratings.
In recent weeks, two candidates have emerged as clear front-runners: centrist, pro-Europe Emmanuel Macron of the newly established En Marche party; and the far-right, anti-EU Le Pen. Le Pen’s pledge to pull France out of the EU and end the use of the euro common currency has raised the level of political risk to new heights in France and across Europe.
Pre-election polls show that Macron is highly likely to defeat Le Pen in the May 7 runoff. But after Trump’s surprising win, and the shocking outcome of the Brexit vote, the populist Le Pen cannot be ruled out. In my assessment, a Le Pen victory is a low-probability, high-risk event that is causing many international investors to stay cautious. That is not a bad approach given the substantial downside if Le Pen wins.
Throughout the U.S. presidential and Brexit campaigns, the polling results were within the margin of error, pointing toward a close race in France. Le Pen is currently polling far outside the margin of error in the second-round runoff, making it extremely unlikely that she could pull off a last-minute win.
Investors in French financial assets are nervous about the upcoming elections but are not panicking. (Not yet, anyway.) Equity markets have remained relatively stable so far this year, moving roughly in line with others around the globe. The French bond market, where the impact of political risk can be seen more clearly, is showing more anxiety. In recent months, yield spreads have widened significantly between French government bonds and the perceived safe haven of German government bonds.
The divergent views of equity and fixed income investors are not surprising. Many of France’s largest publicly traded companies — Airbus, L’Oréal, LVMH, Sanofi, Total — are global enterprises that are not dependent on the French economy. In many cases, their earnings potential depends more on what happens in the U.S., Asia or other parts of Europe.
French bonds would be severely impacted by currency devaluation and large-scale capital flight if France were to abandon the euro and leave the EU. That impact would likely extend to peripheral bonds, as well (Italy, Spain, etc.), given their relatively weak profile amid the eurozone breakup risk. In fact, such a serious threat to stability would probably result in a major financial crisis, given global linkages between the eurozone and other global equity and fixed income markets.
My base case is that Macron wins the presidency and French financial markets enjoy a brief relief rally. However, if Le Pen wins, it may very well mark the end of the eurozone as we know it, because one of the principal architects of the monetary union would have elected a Euroskeptic leader. That would start a messy, high-stakes period of negotiations in Brussels and Berlin to see whether a compromise could be found. In that scenario, it would take quite some time before it became clear which direction France (and Europe) would take, or if indeed there would be a French eurozone exit referendum.
Unless the National Front can win the presidency and gain a majority in the National Assembly elections six weeks later (which is extremely unlikely), Le Pen will have a difficult time moving her nationalist anti-EU agenda through an uncooperative legislature. The National Front has little support outside its own membership; therefore, establishing a coalition government with other French parties would be nearly impossible.
However, if Macron wins, he would probably face a similar dynamic, given his recent break with the Socialist party and his lack of political experience. (Macron served as economic minister under Hollande, but he has never before held elected office.) He is a rising star, no doubt, but the rough-and-tumble world of French politics is a daunting environment for a relative newcomer. It’s possible that no matter who wins this election, France may endure policy stagnation amid a visibly stretched political system.